Lynas Rare Earths (ASX:LYC) has had a rough month with its share price down 2.0%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Lynas Rare Earths' ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Lynas Rare Earths is:
33% = AU$541m ÷ AU$1.6b (Based on the trailing twelve months to June 2022).
The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.33.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Lynas Rare Earths' Earnings Growth And 33% ROE
To begin with, Lynas Rare Earths has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. As a result, Lynas Rare Earths' exceptional 62% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared Lynas Rare Earths' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 33%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is LYC fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Lynas Rare Earths Using Its Retained Earnings Effectively?
Given that Lynas Rare Earths doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
On the whole, we feel that Lynas Rare Earths' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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